Grantham Mayo: "Whiplash: On Value, Growth, and Ignoring the Fundamentals"

After a decade of lagging relative returns, value equities delivered impressive performance in 2016,
outperforming growth stocks by 10% in the US.

As Exhibit 1 indicates, value started to break away
in the second quarter due in part to an improving economic outlook and a view that central banks,
in particular the US Federal Reserve, would pivot toward a more neutral monetary policy. The spread
between value and growth widened markedly in the fourth quarter as 10-year Treasury yields rose and
the budding reflation theme strengthened on the back of the election of President Trump.

In 2016,
the Russell 3000 Value index, bolstered by gains in sectors such as Financials, Energy, and Materials,
rose 18.4% while the Technology and Consumer Staples laden Russell 3000 Growth index chalked up
gains of only 7.8%. The story looked quite similar from a global perspective with value outperforming
growth by approximately 8% and 7% in EAFE and the emerging markets, respectively.

With an almost artistic sense of symmetry, the markets have all but completely erased last year’s gains
for value over growth thus far in 2017. While the US Federal Reserve has continued to telegraph rising
short-term rates, a sign of faith in a firming economy, many of the supposedly pro-growth policy
initiatives of the new US administration seem to be bogged down already. In response, the US yield
curve has flattened and investors have shifted allegiance from cyclical opportunities to growth names.
Outside of the US, value and growth were more in sync until mid-March, at which point the relative
returns moved significantly in favor of growth.

Style shifts are common, but the magnitude of the change from late 2016 to early 2017 has been
particularly dramatic. As the histograms in Exhibit 3 show, value’s outperformance in the last 5 months
of 2016 was quite strong. The Russell 3000 Value index outperformed its growth counterpart by 6.7%
during that period, a 90th
percentile outcome. Value’s 10.4% underperformance relative to growth in
2017 through May was an even more extreme 5
th
percentile event, meaning only 5% of all the 5-month
periods dating back to 1990 have seen value underperform by as much as the style has this year.

The
story has been similar outside the US. EAFE value delivered 97
th
percentile outperformance of 11.6%
in the last 5 months of 2016, followed by 5.9% of underperformance (a 5
th
percentile reading) this
year through May. While it took emerging growth a bit longer to pull away from value this year, the
5-month relative returns marked a similarly extreme style shift from late last year. After delivering
strong relative returns in late 2016, emerging value (measured by the S&P IFCI Value and Growth
indexes) trailed growth by nearly 6%, a 3
rd
percentile outcome going back to 2004....